Don't Mess With Taxes

Current political talk (OK, fights) on Capitol Hill is full of discussions (OK, fights) over how and how much to tax the rich.

The discussions (OK, fights) are driven by the fact that the tax code already is full of provisions that help the wealthiest among us stay that way. But some of the tax laws can help all of us, regardless of our income level, increase our relative wealth.

And some of those Internal Tax Code components are adjusted each year for inflation.

This Part 6 of the ol' blog's annual tax inflation series looks at how these annual tweaks help with the taxes on:

• investments that can help build wealth,
• financial gifts we give now and ultimately leave to our heirs, and
• money made by youngsters who are following in their families' investing footsteps. 

Lesser tax bite for capital gains: It's no secret that richer people tend to take the approach that that it's better to make your money work for you than to work for your money. Essentially, they get much if not most of their income from investing.

Part of the appeal here is that when investments are long-term, the profit they produce is taxed at a lower rate. The tax rates on the proceeds from assets held for more than a year are 0 percent, 15 percent and 20 percent. Which one applies depends on your overall income and filing status.

Thanks to changes made by 2017's Tax Cuts and Jobs Act (TCJA), there are separate income brackets for the three capital gains tax rates. The earnings to which the three long-term capital gains tax rates will apply in 2022 are shown in the table below:

For comparison, and to use where you're figuring your 2021 taxes, here are this year's long-term capital gains rates and income brackets:

In addition to capital gains tax rates listed in the tables, higher-income taxpayers may also have to pay an additional 3.8% net investment income tax.

And yes, there are other capital gains tax rates for other holdings, like collectibles, but they are affected by inflation.

Uncle Sam also collects capital gains taxes on estates and trusts.

For 2022, the maximum zero capital gains tax rate applies to estates or trusts worth up to $2,800. The top earnings level for an estate or trust to be taxed at 15 percent is $13,700. The 20 percent rate applies to these entities worth $13,701 or more.

For estates and trusts in 2021, the maximum zero capital gains tax rate applies to estates or trusts worth up to $2,700. The top earnings level for an estate or trust to be taxed at 15 percent is $13,250. The 20 percent rate applies to these entities worth $13,251 or more.

Estate tax exemption increase: Thanks to your investments over the years, you've been able to fulfill the goal of providing for your family here and now. You've also accumulated enough to be able to leave a generous amount to your heirs.

Other changes in the TCJA nicely reward such bequest generosity, and the inflation bumps help, too.

Most of us don't have to worry about the federal estate tax. A portion of what you leave is free from taxation by Uncle Sam. This estate tax exemption amount also is adjusted for inflation.

For 2122, the inflation adjustments will allow an individual to leave heirs a tax-free estate of up to $12.06 million. That's a nice increase from 2021's nontaxable estate assets level of $11.7 million.

Note, too, the estate tax-free amount is per person. That translates to an estate tax exemption amount in 2022 or $24.12 million for a married couple next year. That's up from 2021's $23.4 million combined estate tax exclusion amount for a wedded duo.

When an estate exceeds those tax year amounts, then and only then is the federal estate tax, which can go as high as 40 percent, assessed on the overage.

Obviously, these ever-increasing (at least until the TCJA expires at the end of 2025 or is changed before then) multimillion-dollar exclusion amounts mean that the hubby and I — and our families and our friends — likely will never have to worry about the federal estate tax … unless we win the lottery or we get new, richer friends!

Note, though, that you might have to worry about the state tax collector. A handful of states and the District of Columbia still have either an have an estate or inheritance tax — our old Maryland stomping grounds has both — and their exclusion levels are much, much lower than the federal level.

Tax-free gifting, too: Sometimes people want to share their wealth while they are still around to get the thanks for their generosity.

Not only is that a heartwarming move, it could be tax smart. Giving away some of your assets could help keep your eventual estate out of Uncle Sam's hands when death and taxes finally converge.

The tax code allows you to give a specific amount, known as an annual exclusion, in gifts to others. This will help reduce your estate's value and there's no tax ramifications for the gift recipients.

For 2022, that exclusion amount is $16,000 per person. That's a grand more than the $15,000 you can give away — remember, Christmas is coming up quickly! — for the 2021 tax year.

Like the estate tax exemption, the gift exclusion limits each year are per person. That means if you're married, you and your spouse each can give a combined $30,000 to the same person in 2021 and $32,000 in 2022.

Pulling out my handy calculator, that also means that a married couple with three kids and five grandchildren can each give those eight family members a combined gift total of $240,000 this year and $256,000 in 2022 without facing gift tax consequences.

And despite my example, you (and your spouse) also can give these gifts of $15,000 in 2021 and $16,000 in 2022 to folks beyond your family. That's right. There's no familial relationship requirement. So if you have some spare cash and really enjoy the ol' blog, just let me know.

Also, the gifts are not limited to dollars. You can give assets valued up to the limit, such as gifts of real property and family heirlooms.

By bestowing your cash and property beforehand, you can reduce the amount of your assets left to be distributed after you're gone. This is a good way to dole out your estate the way you want and keep its value under the amount that will trigger the federal estate tax.

Even better, as long as you follow the rules, you won't face any gift tax.

Best of all, for those on your list, your gifts are not taxable to the recipients.

Adding up all those gifts: The major tax-related gifting rule is, of course, that you can't just give away all your riches to escape the tax collector. That's why the lifetime gift exemption, aka the unified credit against the estate tax, was created.

As the name indicates, the lifetime gift exemption is the total amount of gifts that can be given away tax-free by a person over his or her lifetime to any number of people.

It's easy to keep track of because it's the same as the annual estate tax exemption amount.

Again, thanks to inflation that's $12.06 million (or $24.12 per married couple) in 2022 and $11.7 million or $23.4 million for a married couple this year.

This unified limit is necessary because without it, rich folks might be tempted to simply give away the bulk of their money or property while living to avoid estate taxes after death.

If you do go over the lifetime gift exclusion, you will owe a 40 percent tax on those excessive gifts.

Counting the kiddie tax: Your children and investments also come into tax consideration well before estate tax and gift implications, especially if you including them in your family's wealth building and preservation plans.

Children often receive monetary gifts from their parents or other relatives. When those family financial gifts are assets or the youngster decides to invest the cash, it's a good way to teach the child about making money work for them rather than just working for money.

However, all family members need to be aware of potential tax costs here. Specifically, young investors and their parents need to keep an eye on the annual amount of their unearned income. This is money from things like dividends and interest, not the money young people earn from jobs.

When young people — up to age 23 if a full-time student or 18 if not going to college — have unearned income that exceed certain limits, the kiddie tax comes into play on those successful investments.

The kiddie tax first appeared in 1986 as a legislative way to close a tax loophole for the wealthy. After a certain earnings level, a child's investment income was taxed at the same rate as that of their parents. By effectively raising the potential tax on the youngsters' passive income, the idea was that well-to-do adults wouldn't be so inclined to shift their wealth by putting it in their lower-taxed children's names.

So what's the earnings amount that triggers the kiddie tax?

For 2022, a young investor's first $1,150 of unearned income is not taxable. That's a bump up from the first $1,100 of unearned income that's not taxable in 2021.

Then the next $1,150 in unearned income in 2022 ($1,100 in 2021) is taxed at the child's tax rate, typically the lowest 10 percent rate.

Only when a child's investment earnings top the combined limit — $2,300 in 2022 (the untaxed $1,150 and the next $1,150 taxed at the child's rate) and $2,200 in 2021 — is the young financier's excess unearned income is taxed at higher rates that typically apply to their parents' taxes.

Parents can opt to include a child's gross income in the adults' gross income and calculate the kiddie tax there. One of the requirements for this parental election is that a child's gross income for 2022 must be more than $1,150 but less than $11,500; for 2021 the range is more than $1,100 but less than $11,000.

Estate and trust tax rates: Wait. There's an estate tax and estate and trust taxes, too?

Yes. Earnings from trusts and estates have their own tax rate schedule for income that trustees choose to retain rather than distribute to beneficiaries.

Under this system, higher rates kick in at lower income levels than the tax rates and income brackets for individual taxpayers. The design intentional to keep trusts from being used as tax shelters.

However, the TCJA lowered tax rates for trusts and estates, just like it did for individuals, at least through 2025. It also reduced the number of trust and estate tax brackets from five to four.

The estate and trust tax rates for 2022 and 2021 are shown in the table below.

Get tax help, more inflation updates: Obviously, when you're talking inter-generational income and how to make, preserve, distribute and pay taxes on it, things, like families, can get very complicated very quickly.

I guess being wealthy is not as easy as it looks. But I'd certainly be willing to give it a try.

If you are at a higher income level and need to consider any of these family wealth and investment issues, remember that this post and inflation amounts are just informational. Before you go trying to set up a tax-wise estate plan, your best first move is to hire a good financial and tax adviser.

That adviser can help you deal with not only the capital gains and kiddie and estate taxes in this Part 6 of my annual tax inflation series. As the box below notes, you can find a directory to all 10 parts in the first post of the series.  

This post on 2022 investment and estate and kiddie and more taxes
and how the upcoming amount revisions is Part 6
of the ol' blog's annual series on tax inflation adjustments. 
The 10-part series started with a look at next year's income tax brackets and rates.
That first item also has a directory, at the end of the post,
of all of next year's tax-related inflation updates.
If, after perusing this post on deductions and credits, you want to check out
other inflation adjustments for 2022, you'll find the links, when posted, there.
Note: The 2022 figures in this post apply to that tax year's returns to be filed in 2023.
For comparison purposes, you'll also find 2021 amounts that apply to this year's taxes that,
pending any COVID-19 Tax Day delays like we've faced the last couple of years, will be due April 15, 2022.

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